BE368 Lecture 4
BE368 Lecture 4
BE368 Lecture 4
Matlab
Lecture 4: Linear Regression
Mark Hallam
University of Essex
3 Nov 2022
Linear Regression
I Concepts and definitions: sample and population regression
functions, variables, errors and residuals
I Estimation and inference: estimating linear regression
models, predicted values, alternative functional forms, tests of
significance, R-squared and other regression statistics
I An application: capital asset pricing model (CAPM)
y = β0 + β1 x + e
y = β0 + β1 x1 + β2 x2 + . . . + βk xk + e
y = Xβb + u
E [ri − rf ] = βi E [rm − rf ]
r¯i,t = α0 + α1 r¯m,t + et
40
20
Excess return on asset
-20
-40
-60
-30 -20 -10 0 10 20 30 40
Excess return on market
Mark Hallam University of Essex
BE368: Lecture 4
Example: Capital Asset Pricing Model
I We can repeat this for the other 16 industry-based portfolios
to obtain their market βs in the same way
I According to the CAPM, we should see a linear relationship
between the β of an asset and it’s expected return (known as
the security market line or SML)
I Line has intercept equal to the risk-free rate (β = 0) and for
β = 1, it equals the expected return on the market portfolio
1.2
1
Return
0.8
0.6
0.4
0.2
0 0.5 1 1.5
Beta
1.2
Cars
1.1
Machn
Chems
Cnsum
Oil Rtail
Return
Finan
1 Food Cnstr
Clths Trans
FabPr Durbl
Mines
0.9 Other Market
Steel
Utils
0.8
0.7
0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5
Beta